This review follows our report Mortgage lenders’ arrears management and forbearance (TR14/3, February 2014).
In the report we asked firms to:
- consider which borrowers are most likely to be affected by potential rate rises
- deal sensitively with borrowers who may have particular vulnerabilities
- take action to identify customers susceptible to falling into arrears
- have appropriate strategies to treat these customers fairly
In addition, since April 2014, we have required firms to consider the effect of expected future interest rate increases as part of an affordability assessment for a new mortgage. This assessment must also consider the Financial Policy Committee’s recommendation on appropriate interest rate stress tests. This is consistent with a framework in which the regulators assess a range of possible future outcomes from a stress testing perspective.
We set out to understand what strategies mortgage lenders have in place to mitigate the impact of an interest rate rise on financially vulnerable customers (i.e. those less able to cope with an increase in their monthly payment, including customers not currently in arrears).
We started this review in early 2016, at a time when an interest rate rise was anticipated. Since then, interest rates have been cut and we recognise that preparing for interest rate rises may not seem like a high priority. Nevertheless, we have decided to share the results of our review to assist firms and customers to prepare for when interest rates do rise. In other areas of our work we are assessing the impact of rates remaining low.
Our review focused on the treatment of existing customers, which is an FCA priority as indicated in our Business Plan. We reviewed 9 firms including retail banks, building societies and non-deposit taking lenders. We are encouraged that most firms have acted following publication of our previous thematic report and our Occasional Paper No.8: Consumer Vulnerability.
However, we found firms are at different stages in developing strategies to mitigate the impact of an interest rate rise on financially vulnerable customers and for some it appears that more work is needed before these strategies will be ready to implement.
Identifying financially vulnerable customers
Most firms in our review had considered what characteristics may make a customer more vulnerable to a rise in interest rates and had built their analysis around this – however these characteristics varied from firm to firm.
Firms carried out a range of work to identify their most financially vulnerable customers, which included:
- identifying customer segments using credit reference agencies to analyse payment profiles, indebtedness, affordability and behavioural measures
- stress testing across different rate rise scenarios to identify the impact on Contractual Monthly Instalments (CMI)
Some firms have excluded certain customer types from their analysis which could result in poorer outcomes for those customers. This included:
- customers currently in arrears - some firms view their existing collections procedures as accommodating such customers
- fixed rate customers, in some cases irrespective of the time until product maturity
Firms are at different stages in developing strategies to treat customers fairly when interest rates rise, with some appearing more prepared than others. Most firms have carried out analysis to assess the number of customers and level of impact on those most vulnerable to an interest rate rise. However, it appeared that few firms would be able to implement strategies if interest rates were to rise in the near future.
Examples of strategies that more prepared firms have developed included:
- carrying out research to understand what customers know about the type of mortgage they hold and what the potential impact of an interest rate rise would be for them
- removing barriers that could prevent existing customers transferring to other products in order to lessen the impact of an interest rate rise - for example, one firm had removed loan-to-value limits for product transfers
- providing all front-line staff with training to help them recognise signs of financial difficulty and know when to refer customers to a specialist area
- developing online mortgage calculators to help customers check the potential impact of an interest rate rise, showing customers where to seek support
Where firms have communicated with customers, we found that most of the communications were generic messages highlighting potential interest rate rises, and weren’t specific to the customer’s personal circumstances.
Examples of more developed communication strategies included:
- writing to customers, providing specific details of the impact of a rate rise on their monthly payment, clearly setting out the options available and encouraging them to take steps to prepare for an increase
- developing outbound communication strategies based on risk - for example, higher risk customers prioritised for outbound calling which is then followed up with written communications
- developing communications to raise awareness of the potential impact of a rate rise, and the action customers can take to prepare in advance
- piloting customer contact exercises (focusing on those more susceptible to a rate rise) to test engagement and inform strategy development
- working collaboratively with debt advice agencies to develop ways to communicate with those customers most likely to be impacted by a rate rise
Monitoring the impact
We found that most firms produced Management Information as part of their analysis to assess the impact of an interest rate rise on the overall mortgage book but only one firm reviewed this regularly.
Preparing for an interest rate rise
Firms can take steps now to be better prepared and do not have to wait until an interest rate rise to develop strategies. By understanding the numbers of customers likely to be impacted by a rate rise and developing strategies, firms could reduce the risk of customers entering arrears or arrears positions worsening.
This can also help firms to understand the potential impact on their resources if rates do rise (e.g. extra staff needed to deal with financially vulnerable customers and considering the impact on customers currently in arrears).
Role of customers
We also recognise that customers have a role to play and need to take responsibility for their finances. We are encouraging customers to regularly review their mortgage arrangements, consider the impact an interest rate rise could have on them and to take necessary steps, where possible, to budget for an increased monthly payment.